Use a System Based on How the Market Actually Works
10 Tools for Your Investing Toolbox
Want to Get Away? Take a Staycation!
In preparation for today’s Cabot Wealth Advisory, I went back and read our in-house recap of a recent survey we sent you. While it was expressed a few different ways, the most common response was some form of “Help me make money by helping me know when to buy, sell, be in and out of the market …” and so on.
Part of that, of course, involves what stocks to buy–and I’ll get to that later in this Advisory.
But most of it (far more than most investors understand) comes from having a solid foundation of what works, and what doesn’t, in the stock market. In fact, I like to say that the system we use in Cabot Market Letter and Cabot Top Ten Report (both of which I edit) is not MY system, per se, but the MARKET’S system–it’s based on what has actually produced profits during the past many decades.
For me, it’s easy to follow a system like that because I was born and bred into it. When I first became interested in the stock market, I didn’t have any leanings one way or the other; I started with a clean slate. And I was naturally attracted to systems that made the most money in the market. I wasn’t looking for some dude who sounded good on TV–I wanted profits!
That’s why the system I follow is one that is based on what has worked over and over again in the past 50 years, including what stocks look like when they break out, how they act while they advance and what warning signs mark meaningful tops. The same goes with the overall market … at Cabot we have charts going back to 1920, showing us what all the major tops and bottoms looked like.
Thus, when I tell subscribers that, say, the education stocks have topped out and they should be sold (which I did for Cabot Top Ten Report subscribers in mid-February), it’s not because I came up with an opinion willy-nilly. No! In that case, it was because every stock in the group suffered outsized price drops on huge volume, with some breaking their 50-day moving average. That’s a sell signal.
(Editor’s Note: Mike Cintolo, as editor of Cabot Market Letter, has used his “how the market actually works” knowledge to produce great results during both bull and bear markets. In fact, since the last bear market bottom–way back in March 2003, exactly six years ago–the S&P 500 is down 18%, and the Nasdaq has also lost money. But Mike has nearly doubled his subscribers’ money (up 95%) during this time! He does it with spot-on market timing, an eye for finding the very best leading stocks, and a set of proven rules and tools, many of which he details below. If you’d like to follow Mike’s proven program, sign up here.)
So how can this help you? I gave you a couple of helpful hints to timing the market in my last Cabot Wealth Advisory (http://www.cabot.net/Issues/CWA/Archives/2009/03/Easy-Way-to-Time-the-Market.aspx), and today I want to give you 10 nuggets to put in your investing toolkit.
1. Most big-winning stocks advance for 12-24 months, from breakout to top: In other words, if you’ve owned something for more than a year and it’s been pretty much straight up, the stock’s likely in the latter stages of its advance. True, some great stocks (take Apple, for instance), can go up longer, but even then, the stock tends to have a very nasty (50%+) correction, something that’s hard to sit through.
2. Most big-winners in new bull markets are new stocks: By new, I mean most stocks have come public during the past few years and did NOT enjoy spectacular run-ups during the prior bull market. So if all your attention today is on Apple, Google, First Solar and the like (or even worse, Citigroup, A.I.G. and Bank of America) then you’re looking under the wrong rocks. A corollary of this is that only one or two out of 10 leaders of the last bull market end up leading the next bull market. It’s possible, but unlikely.
3. The best stocks begin their runs when they break out to new 52-week highs: When a stock is moving up off its lows, like so many have in recent days, it’s tempting to jump onboard. However, these stocks have quick moves, and also quickly hit resistance. So to make money on these names you either have to buy early (not recommended), or have impeccable timing (difficult). Contrarily, the biggest winners have chewed through all potential sellers, and begin their moves from their breakout into new-high territory.
4. The biggest winners will breakout to new highs within a few weeks of a market low: If you’re buying a bunch of beaten-down stocks after a major market low, you’ll probably do OK … but you won’t own any true leaders, and your performance will eventually lag.
5. The 50-day moving average will contain most of a great stock’s intermediate-term advance: Usually, once a winner gets going, it will find support a couple of times at the 50-day moving average. That means, if your stock breaks decisively below its 50-day line, it’s probably time to sell and move on.
6. If an entire group is strong for many weeks, and then most stocks suffer their biggest drops in many weeks, then a top is likely in: This is what happened to the education stocks a few weeks ago, which I wrote about above, and also happened to the commodity stocks in early July 2008. This could give you an early-warning sign, instead of waiting for the trailing 50-day line.
7. A big move (more than 10%) the day after an earnings release usually leads to more movement in that direction. Nobody likes to sell after their stock has just been crushed 20% on an earnings announcement, but that’s often the best thing to do. Same goes on the upside–a large move higher on earnings is often buyable (if the market is healthy, of course). The bigger the move, the more meaningful it is.
8. “Strong then Tight = Flight”: This is a great rule of thumb. If you see a stock break powerfully to new highs (Strong), and then trade in a tight range, say, within 10% for couple of weeks afterwards (Tight), it’s usually a sign that big investors are still accumulating shares, and the next big move will be up (Flight). This is one of my favorite set-ups.
9. A stock split (or stock split announcement) will often mark a meaningful top for a stock: Most investors, for some reason, have been trained to think of stock splits as good. But if your holding has been advancing for many weeks (at least a couple of months), and then spikes on stock-split news, you’re usually better off selling at least some of your shares.
10. Good stocks can go bad in a hurry in bad markets: Last but not least, you should always keep in mind what the market is doing. Is it trending lower? If so, no matter how good the set-up, you’re more likely to lose money. If it’s trending higher, it’ll be like running with the wind at your back. Using the 50-day moving average on the major indexes (like I wrote about in my last Cabot Wealth Advisory) is a simple-but-good way to know whether the trend is up or down.
Now, I know not all of these rules and tools will be of help right now, but if you print these out and refer to them, I guarantee they’ll come in handy sometime in the months ahead.
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Now on to specific stocks, and the current market environment. As you know, the market’s been acting well for the past week or so, with the major indexes rallying after a terrible February and early March. By my measures, the market’s overall trend is still down (though barely), so I’m content to wait for our indicators to turn up before plunging in.
Thus far, most of the action has come from the off-the-bottom stocks. You know what I mean–the stocks that fell from 70 down to 8 and have now rallied to 13. It’s something that needs to happen for the market to get going, especially in the beaten-down financial stocks. But those aren’t high-odds investments.
Anyway, it’s at times like this that I step up my research and look for any broad industry themes. Honeslty, there aren’t many, but two come to mind.
First is gold. The entire group enjoyed a HUGE volume advance on Wednesday after the Fed announced it was going to buy hundreds of billions of dollars of this, that and the other thing. Investors are clearly thinking the Greenback will be under pressure while the Fed prints money.
But beyond gold is a unique “group” that is benefitting from the current downturn in the economy–the “staycation” stocks. Actually, these are really companies that help cash-strapped consumers by offering cheap merchandise and entertainment options. Sounds simple–and it is. And the stocks are acting very well.
Netflix (NFLX) is a stock we’ve mentioned many times. Heading to the movies with a family of four can easily cost upwards of $50 once you add in all the candy, popcorn and drinks. But Netflix’s service starts at just $10 a month, allowing for many family movie nights at home (likely with cheaper, store-bought popcorn, too). The stock is hitting new highs.
American Italian Pasta (AIPC) makes … pasta. But pasta is cheap, and more families are trying to feed a whole family without gouging the checking account. The company is a turnaround story with new management, lower raw material costs and lower legal fees. The stock is consolidating after a big run.
Family Dollar Stores (FDO) sells lots of stuff for a buck, including many basic home goods. Why spend more for a can of soup or a tube of toothpaste when you don’t have to? The stock gapped up on earnings on March 5 and has crawled higher since. It might need a pullback here.
Green Mountain Coffee (GMCR) owns Keurig, the self-operated, single-cup brewing systems that are gaining popularity in offices and homes. Instead of paying a few bucks at Starbucks, people can easily brew their own coffee in just a few seconds at home, for less money. The stock nosed out to new peaks on low volume this week–it probably needs more time before getting going.
However, one thought occurs to me; if the market is truly entering a sustainable advance, it’s likely discounting a better economy. And if that’s the case, maybe the demand for cheap products (and these stocks) won’t be as great. We’ll see how it plays out, but as of today, these are among the strongest stocks in the market.
Until next time,
For Cabot Wealth Advisory
P.S. This week, Peter Brimelow of CBS MarketWatch wrote about the outstanding performance Cabot Market Letter achieved based on its market timing system. Click below to read the article and to learn more about the time-tested system that saved Cabot Market Letter subscribers a bundle during last fall’s market crash.